Fincorp - A Painful Lesson on Risk - Eureka Report Article
About six months ago Eureka Report published a story about the unquestionably seedy underside of fixed-interest investments, Fixed Yields can be Costly. The story focused on Fincorp, a provider of "unsecured notes", which had fundamental flaws in its structure.
Now Fincorp is in crisis. After Perth-based First Capital pulled out of a plan to buy the company in recent days, Fincorp management called in administrators KordaMentha. The reasons for the failure of Fincorp will come out over time, although the criticism that I made in the article last October - related-party loans, capitalising interest, high-risk property construction assets - will no doubt feature as causes of the collapse.
Initial reports suggest that there are 8000 small investors who will be affected, twice the number caught in the Westpoint collapse, with a total at risk of $300 million. The impact on these people as they start retirement or plan for retirement will be significant.
There is a common theme between Westpoint and Fincorp, and that is the aggressive marketing that was employed by the promoters behind both schemes. At Westpoint "distribution" was through commission-based financial planners. At Fincorp the distribution was through direct advertising campaigns, including press, radio and website advertising - especially on commercial radio stations such as 2GB in Sydney.
There is another key marketing plank in both schemes, the way returns were advertised carefully hid the reality of investment risk. The schemes advertised fixed-income returns paid on a regular basis, not dissimilar to a cash account return. This hid the reality that the underlying investments of these schemes were related to property construction projects. Property construction - especially if it is linked to the promoters raising the money in the first place - is a risky investment in anyone's language.
The reality is this: an investment scheme offering high returns must be high risk; there is no getting around this. This reality hardly comes through in their advertising campaigns, where the regular income is highlighted to such an extent that people can't help but see these as the ideal "one stop" investment solution. A 10% income return paid monthly when bank accounts are offering 6% - it seems like the ideal solution.
This is not the first collapse of such a scheme. The recent failure of Westpoint is still at the top of everyone's mind, and I still run into many people who suffered financial losses from the Estate Mortgage collapse in the early 1990s.
Is there a common thread?
All three funds - Fincorp, Westpoint and Estate Mortgage - relied on property assets for the success of their fund, had high fee structures and relied on aggressive marketing to get investors involved. In the case of Fincorp, this was through direct advertising whereas Estate Mortgage and Westpoint relied on high commission payments to financial planners.
Of course, the strongest link of all was the ability of all three funds to make investors temporarily forget that risk and return must be linked.
Think of Westpoint. Why was it offering returns of 12%? Because the group could not get finance from a bank at 8%, or from a mortgage fund at 10%. That meant Westpoint had to offer higher returns than other market competitors to pull in investors who would otherwise have not had anything to do with them.
The rule that risk and return are linked should protect all investors from: